The Different Types of Risk

Last week’s commentary about how tolerance for risk changes with age prompted a few readers to respond. Most of the emails I received focused on defining what risk is. In the world of finance, risk has more than one definition.

Risk questionnaires often try to assess a person’s willingness to incur a drop in a particular investment or net wealth. For example, Vanguard’s risk assessment questionnaire asks respondents to choose one out of three hypothetical $10,000 investments. The least volatile option has a very minor one-year downside (a loss of $164), while the most volatile investment could experience significant losses ($3,639) over a one-year period. Schwab asks respondents what they would do if the stock market lost 25% of its value within three months. Other firms ask similar questions.

Risk in these cases is being assessed in terms of a person’s ability to withstand losses. The questionaires are designed to assess an individual’s psychological ability to handle shorter-term drops in their wealth. It’s logical to do so since many investors panic and sell whenever the market conditions turn turbulent. We humans are hardwired to disdain losses. However, a drop in price—real or hypothetical—isn’t the only way to assess risk.

More on AAII.com

Why a New Allocation Approach Is Needed – AAII founder James Cloonan explained why he believes the traditional way of allocating portfolios fails to consider how risk actually occurs in the real world.

How Big Is Longevity Risk? – The uncertainty of how long a person will live poses negligible risk at younger ages, but substantial risk at older ages.

AAII Sentiment Survey

Pessimism rebounded to a six-week high, but continues to be below it’s historical average. Plus, AAII members discussed how fourth-quarter earnings have impacted their sentiment. More about this week’s results.

The week’s first economic report will be the January S&P Case-Shiller home price index and the Conference Board’s March consumer confidence survey, released on Tuesday. The second revision to fourth-quarter final GDP, February international trade and February pending home sales will be released on Wednesday. Thursday will feature February personal income and spending, the March Chicago Purchasing Managers Index (PMI) and the University of Michigan’s final March consumer sentiment survey.

Four Federal Reserve officials will make public appearances: New York president William Dudley and Cleveland president Loretta Mester on Monday; Atlanta president Raphael Bostic on Tuesday and Wednesday; and Philadelphia president Patrick Harker on Thursday.

The Treasury Department will auction $30 billion of two-year notes on Monday, $35 billion of five-year notes on Tuesday and $15 billion of two-year floating rate notes (FRNs) and $29 billion of seven-year notes on Wednesday.

Local Chapter Meetings

AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!